Small business owners and managers have to make numerous critical decisions every single day. Management accounting tools help them make such decisions by providing data-driven input hence improving decision making for their businesses. In this article, we highlight the most important ones.
The 3 most important management accounting tools
#1 Financial statement analysis
Financial Statement Analysis is one of the important management accounting tools that focuses on financial accounting information for your business.
What is a financial statement?
A financial statement is a declaration of retained earnings, changes in financial position, balance sheet, and profit and loss accounts and is critical in management accounting tools. In general business practice, financial statements refer to the balance sheet and profit and loss accounts. The analysis and interpretation of such accounts is what we refer to as financial statement analysis which has become a core function of management accounting.
In addition to the financial statements, some useful schedules are prepared and presented along with the declarations. These may include fixed assets schedules, debtors schedule, creditors schedule and investment schedule.
Importance of financial statements analysis
When all the quantitative information is intelligently analyzed and interpreted, they offer significant facts and correlations about various aspects of the financial health of the business. This enables the business owners and stakeholders to make critical decisions based on concrete information. Wrong and defective decisions are avoided, and the responsible executives are able to avoid hasty and intuitive decisions using these management accounting tools.
All stakeholders in the business can easily understand the technical aspects of the firm through simplified analysis and interpretation. This may not be clearly visible from raw data presented by the financial statements like the balance sheet.
Decisions made based on the financial analysis become palatable to all stakeholders since they understand the dynamics and the complexities of the analysis.
#2 Budget / budgetary control analysis
Budgeting and budgetary control analysis are other valuable management accounting tools. They are based on future information of the business. Budgetary control is a process of preparing budgets for the future period and comparing them with the actual performance of the firm. The comparison of the budgetary figures helps the management to analyze the variances and take the necessary corrective actions without delay.
Importance of budgetary control analysis
Budgetary control analysis has become a valuable tool that helps organizations to manage costs and maximize profits. It defines the goals, policies and plans of the organization hence helping the business focus on the important things.
Budgetary control analysis fixes targets for every department enabling them to work efficiently to achieve those objectives. It also ensures better coordination between various departments and sections of the business. In case of under-performance, the management is able to take up the responsibility.
Budgetary control also promotes cost consciousness on the part of employees hence enhancing efficiency and economical expenditures.
Finally, the budgetary control plans and provides every resource in advance to enable the business run smoothly throughout the financial year.
#3 Cost variance analysis
Cost variance analysis is one of the best management accounting tools, and it focuses on cost accounting information of the business. The primary objective of cost variance analysis is to facilitate cost control and the overall cost reduction. This analysis aids in the application of the management by exception principle of business and relates to the firm’s efficiency. Efficiency shows favorable variance and an award is given to the persons responsible. On the other hand, an unfavorable variance occurs when there are inefficiencies and the responsible persons are enquired to find the cause and a remedial action taken.
Several types of variances can be analyzed to aid decision making and improve business efficiency. They include labor cost variance, material cost variance, overhead variance, controllable variance, uncontrollable variance, basic variance and sub variance. These management accounting tools are necessary for various complexities in business.
Controllable Variances are occasions where an individual or a section or a department can be held responsible for the inefficiency. However, some variances may be uncontrollable in which case the management has no power to control. These are external factors, and the individuals or the management cannot be held liable for the occurrence.
Here is an example of how a variance analysis can be a used in practice: Variance analysis formulas in practice
Importance of cost variance analysis
The primary objective of management accounting tools is to help the management make informed decisions for the greater good of the business. Cost variance analysis enables the management to identify the cause of the variance and take the necessary remedial action. It may also reward employees and managers responsible for favorable variances and lift up the morale of the performing teams.
The sub-division of cost variance analysis highlights the relationship existing between different types of variances and make proper decisions. Additionally, it provides a useful tool for fixing the responsibilities of individual employees, sections or departments of the company.
The organization is able to highlight all inefficient performances within the business and the extent of inefficiencies. This is necessary for crafting effective remedial actions and future decisions.
Cost control is a fundamental component of management accounting tools and cost variance analysis provides the best platform to monitor costs of running a business.
This tool also allows the top management to exercise the principle of management by exception and only the unfavorable variances may be reported to the management.
Uncontrollable variances enable the management and stakeholder to identify external forces affecting the performance of the business and seek corporate understandings where applicable. However, controllable variances are dealt with accordingly and remedial actions are taken to improve the efficiencies.
Cost variance analysis also helps the management to carry out Profit planning works to maximize profits and minimize costs. In general, the tools create a cost consciousness on the employees and improve the operating efficiencies of the organization.
Let’s sum it up
The tools provide a data-driven focus on how to efficiently run small, medium and large business enterprises. Financial statement analysis, budgetary control analysis, and cost variance analysis are just a few examples of management accounting tools you can apply to guide the future growth of the business. By relying on the data obtained from such analysis, the management is able to make decisions aimed at continuous improvement of the enterprise. The decisions will be justifiable based on the intelligent analysis of cost variances, budgetary control, and financial statements, as opposed to relying on individual instincts and guts.
The Chartered Institute of Management Accountants (CIMA) conducted a study regarding the use of management accounting tools back in 2019. It is worthwhile browsing through it.